Be aware of pre-incorporation risks: Bernstein

By Paul Russell, AdvocateDaily.com Contributor

People who pay a deposit for a property on behalf of a company that is not yet incorporated could lose that money if the deal falls through, Toronto real estate lawyer Daniel Bernstein tells AdvocateDaily.com.

Bernstein, a founder member of Weltman Bernstein, cites a recent Ontario Court of Appeal case where a man signed an Agreement of Purchase and Sale for three Toronto properties, stipulating that he was signing as a buyer “in trust for a company to be incorporated without any personal liabilities.”

He provided a deposit of $100,000 to secure the purchase, court documents state, but months later he advised the seller that he wanted out of the deal, and requested to have his deposit returned.

When the seller refused, the man sued, the judgment states, and the appeal court judge agreed with a lower court decision that the deposit should be forfeited.

“This case will remind me that, if I'm drafting a contract for somebody who is entering into the agreement on behalf of a company not yet incorporated, I have to make sure that person understands that if he walks away, he's going to be responsible for the loss of deposit,” he says.

Even though the pre-incorporation contract clearly stated that the buyers were signing “without personal liability,” he says, the liability exclusion does not apply to the deposit should the deal not close through no fault of the vendor.

“Lawyers have to be very careful when explaining this risk to their clients,” Bernstein says, “as the deposit is not part of the pre-incorporation contract, but it stands on its own.”

The court judgment states a “deposit stands as security for the purchaser’s performance of the contract … should the purchaser not complete, the forfeiture of the deposit compensates the vendor for lost opportunity in having taken the property off the market in the interim, as well as the loss in bargaining power resulting from the vendor having revealed to the market the price at which the vendor had been willing to sell.”

“This judgment is very sound,” says Bernstein, “for if the court ruled in the purchaser’s favour, then what's the whole point of giving a deposit?”

He notes that in common law, a deposit is seen as being a security for the performance of a contract.

“Diligent lawyers should be mindful of the responsibilities that their clients incur by signing agreements," he says. “They have to be specific about what is covered by the clause ‘without personal liability.’”

If the liability exclusion was perhaps drafted more specifically, even going to the deposit itself, arguably the buyer may have been able to get back his deposit, Bernstein says.

He notes that s. 21 of Ontario's Business Corporations Act (OBCA), allows somebody to enter into an agreement without liability for the contract.

It reads, “If expressly so provided in the oral or written contract ... a person who purported to act in the name of or on behalf of the corporation before it came into existence is not in any event bound by the contract or entitled to the benefits thereof.”

The court referenced the section, noting “the provisions of the OBCA addressing pre-incorporation contracts do not displace the common law rules governing deposits in real estate transactions.”

Bernstein describes this decision as reasonable and fair.

“If you want to have liability for the deposit as well, you have to specifically say that, and then you might be able to get around this situation,” he says. “Just stating ‘without personal liability’ won't cut it.”